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Toxic CDOs Reincarnated as Re-Remics

They’re baaaaack. Those toxic and worthless colllateralized debt obligations (CDOs) that helped drive banks $400 billion into the red are finding new buyers under a different name: Re-Remics.

Due to the global credit crunch, CDOs sales fell from $227 billion in 2007 to $1 billion this year so Goldman Sachs, J.P. Morgan and at least six other brokerage firms are repackaging unwanted mortgage bonds into Re-Remics. Re-Remic stands for “resecuritizations of real estate mortgage investment conduits,” the formal name of mortgage bonds. Re-Remics supposedly has parts that are structured to guard against higher losses than most CDOs and would allow investors to sell or keep other parts at lower prices that can translate to potential yields greater than 20 percent. For example, a bond trading at 40 cents on the dollar could be split into a piece worth 80 cents and another piece that could then be sold cheaply enough to offer returns as high as 20 percent.

Re-Remics are different from CDOs in some way. Re-Remics are composed of AAA-rated bonds backed by Alt-A mortgages issued to high quality borrowers instead of debt or credit-default swaps based on the lowest-ranking sub-prime mortgage-bond classes. And while CDOs are backed by more than a hundred bonds, Re-Remics typically combine fewer than a dozen which makes it easier and quicker for investors to separate the better debt from the riskier debt.

According to investment experts like Paul Colonna at GE Asset Management, these Re-Remics are just a different version of CDOs; the mechanics are the same but the valuation levels are different. Colonna said GE has considered buying the debt and might make some of its riskier bonds into re-remics. Analysts also think Re-remics may help revive the market for new home-loan debt by moving illiquid bonds to interested buyers.

Firms like Goldman Sachs, J.P. Morgan and Lehman Brothers all hold significant residential-mortgage securities on its books and this restructuring with Re-Remics could throw them a lifeline. These banks can increase the total credit quality of their assets by selling off lower-rated pieces and keeping the better pieces. So, banks are buying the lower-yielding senior pieces and some are also considering buying the bonds for their pension funds. Companies like Transamerica Life Insurance and Reliance Standard Life Insurance also bought Re-Remics this year.

In the first five months of 2008, more than $9.3 billion of Re-Remics were created – triple from a year ago. Re-Remics made up 47 percent of mortgage bonds issued in the period, excluding those guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.